To determine a suitable investment strategy, financial advisors have historically used a fairly standard risk tolerance questionnaire to evaluate a client’s preferences. These questionnaires often fail to adequately capture someone’s tolerance for market fluctuation. They can also be circumstantial, leading to different answers depending on someone’s state of mind and experience at the point in time that they answer the questions.
We think it’s critical to fully understand a client’s short and long-term goals and their comfort with past money decisions to determine what future investments are in their best interest.
We reviewed an article in Morningstar Advisor magazine recently that presents an interesting new line of questioning. It could be valuable in the “what type of investor are you?” conversation. In the article, author Michael M. Pompain suggests that it helps to understand whether investors are “active” or “passive” in their decision making.
Answer these 10 questions and see how you are classified.
|Question||Response A||Response B|
|Have you earned the majority of your wealth in your lifetime?||Yes||No|
|Have you risked your own capital in the creation of your wealth?||Yes||No|
|Which is stronger: your tolerance for risk to build wealth or the desire to preserve wealth?||Tolerance for risk||Build wealth|
|Would you prefer to maintain a degree of control over your investments or prefer to delegate that responsibility to someone else?||Maintain control||Delegate|
|Do you have faith in your abilities as an investor?||Yes||No|
|If you had to pick one of two portfolios, which would it be?||80% stocks/20% bonds||40% stocks/60% bonds|
|Is your wealth goal intended to continue your current lifestyle or are you motivated to build wealth at the expense of current lifestyle?||Build wealth||Continue current lifestyle|
|In your work or personal life, are you generally a “self-starter” in that you seek out what needs to be done and then do it, or do you normally take direction?||Self starter||Take direction|
|Are you “income motivated,” or are you willing to put your capital at risk to build wealth?||Capital at risk||Income motivated|
|Do you believe in the concept of borrowing money to make money/operate a business, or do you prefer to limit the amount of debt that you owe?||Borrow money||Limit debt|
The response A column suggests an active decision maker who has different emotional biases when making investment decisions than does the response B passive investor.
Understanding how you feel about your investments can be critical to crafting a meaningful asset allocation. It also leads to a better advisory relationship.
Comments about investor behavior or risk tolerance? Let us know what you think. Send your thoughts to firstname.lastname@example.org.
~ BHJ Wealth Advisors — Gig Harbor, Washington